Two Ways to Profit From Europe’s Steady Shift To a Free Market

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By Martin HutchinsonContributing EditorMoney Morning

The European election result has been met with little interest in the United States; for one thing, the plethora of parties from 27 different countries makes it almost incomprehensible. Yet it continued a long-term, very important trend, which should be hugely interesting to international investors.

You see, the longstanding attitude toward Europe – that it is an anti-free-market continent that should be of little interest to investors – is wrong; for the last couple of decades, it has been becoming more free-market-oriented, coming closer to the U.S. economic system.

You can see this more clearly by examining the last four European elections – 1994, 1999, 2004 and 2009 – which have taken place over a period of rapid EU expansion, from 12 countries in 1994 to 27 now. To get a better feel for the trend, you need to classify the various EU parties and their alliances into three broad groupings:

Group I: Socialist/Green – believing in strong state control over the economy, whether for political or environmental reasons.

Group II: Center-right – often nationalist, but believing generally in a free-market economy, although generally with greater government involvement and more welfare payments than in the United States, and finally.

Group III: Centrist/Other – either small center parties holding the balance of power in domestic parliaments or the inevitable residue of the unclassifiable.

Thus, the British Conservatives and German Christian Democrats fall in Group II, as would some smaller parties, like the British U.K. Independence Party and the Swedish Pirate party (which is a small libertarian anti-copyright outfit). The British Labor party, the French Socialists, various hard-left parties and the Greens fall into Group I. The British Liberal Democrats, the German Free Democrats and such economically un-definable parties as the British National Party fall into Group III. This gives anomalies – the German Free Democrats are highly free-market-oriented, for example – but most of them are fairly small and should cancel out.

You can see the trend. The Socialist/Green contingent has declined considerably from 44% of the total to 33%, while the Center-Right has increased moderately, from 40% to 45% (the Group III – liberals and miscellaneous – is a bit overstated for 2009, because many of the small parties haven't yet sorted out which European grouping they will align with). Individual countries swing left and right, as in the United States, but there are enough countries in the EU for these swings to cancel out, leaving only a steady movement towards the Center-right.

One of the causes of this movement is the expansion of the EU – with the exception of the Scandinavian countries, which entered in 1995, most of the new countries are former members of the communist bloc, with an aversion to many aspects of government control. Nevertheless, it's completely consistent across all four elections, not a temporary mood swing. What's more, it's substantial enough to make a big difference in EU policymaking, taking it strongly in the direction of free markets, if not necessarily in the direction of smaller government. A coalition majority sufficient to push through legislation would have been socialist-dominated in 1994; it would now be center-right-dominated.

Investors would do well to bear this trend in mind. Productivity growth has been generally slower in Western Europe than in the United States – but not much slower. In Eastern Europe, however, productivity growth has run at East Asian levels of 5% per annum or more, as the generally excellent education systems and heavy foreign investment of those countries has allowed them to catch up with the rich West. Overall, it's likely that European productivity growth will speed up in years ahead, translating into faster growth in the overall economy, as EU policymakers remove additional trade barriers and pursue reforms that are modestly free-market in focus.

In the United States, meanwhile, the Barack Obama administration looks likely to substantially increase the government's share of gross domestic product (GDP), taking the U.S. economic picture much closer to that of Europe. That may cause U.S. productivity growth to slow to European levels. Of course, as investors we would pay more for an increasing productivity growth trend than a declining one – which is why it is strange that most Price/Earnings (P/E) ratios in the EU are below the 13.6 average of the U.S. Standard & Poor's 500 Index.

To celebrate the EU election result – or to position yourself for the region's favorable prospects – you might look at the Vanguard European ETF (NYSE: VGK), which tracks the Morgan Stanley Capital International Europe Index. With net assets of $1.54 billion and a Price/Earnings Ratio of 8.2, it's a way to get into a huge market on a bargain basis.

[Editor's Note: When the journalistic sleuths at Slate magazine recently set out to identify the stock-market guru who correctly predicted how far U.S. stocks would fall because of the global financial crisis, the respected "e-zine" concluded it was Martin Hutchinson who "called" the market bottom.

That discovery was no surprise to the readers of Money Morning – after all, Hutchinson has made a bevy of such savvy predictions since this publication was launched. Hutchinson warned investors about the evils of credit default swaps six months before the complex derivatives KO'd insurer American International Group Inc. He predicted the record run that gold made last year – back in 2007. Then, last fall – as Slate discovered – Hutchinson "called" the market bottom.

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